Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

Darden Restaurants’ Earnings: The Good, the Bad, and the Ugly

After a disappointing earnings report, what's next for shares of Darden Restaurants?

To say that Darden Restaurants (NYSE:DRI) released a disappointing earnings report is an understatement. The shares dropped almost 4% after the report and rightly so. Earnings per share missed expectations by $0.10. Total revenue came in $10 million below the consensus estimate and only exceeded last year's quarter by 0.9%.

Source: Darden Restaurants

Activist investors Starboard Value and Barrington Capital certainly will not be happy with the earnings report. They have been critical of CEO Clarence Otis, and this report does not make matters better. After all, shares of Darden Restaurants are trading at the same level where they were three years ago. The only consolation for investors has been the 4.6% dividend yield. Compare this to fast-casual operator Chipotle Mexican Grill (NYSE:CMG) or Brinker International (NYSE:EAT), with share prices that have both doubled in the same time-frame. This Fool asks, what's next?

First, the good newsSome bright spots appeared in the report. Longhorn Steakhouse once again proved that it is the company's crown jewel. Same-store sales rose 2.4% for Longhorn Steakhouse in the fourth quarter. For the full fiscal year, Longhorn Steakhouse's total revenue increased over 12%.

Source: Longhorn Steakhouse

Among the specialty restaurants, gains were led by Bahama Breeze and The Capital Grille, which posted same-store sales growth of 4.1% and 4%, respectively. The Capital Grille benefited from a rising stock market as it's a go-to place for high-income spenders.

Source: Bahama Breeze

On the expense side, Darden Restaurants was able to get general and administrative expenses down to about 5% of total sales. This year, Darden Restaurants expects its selling, general, and administrative expenses to make up the lowest percentage of sales ever in the company's history as a public company.

Now, the bad newsWith the sale of Red Lobster to Golden Gate Capital for $2.1 billion, Olive Garden will now account for the bulk of the company's sales. Darden Restaurants is counting on Olive Garden for improvement. Unfortunately, that did not happen in the fourth quarter. Same-store sales fell 3.5%. For the full year, same-store sales at Olive Garden were 3.4% lower than they were in the prior year.

And finally, the uglyWhile Darden Restaurants remains the largest operator of casual-dining restaurants in the country, it is facing stiff competition from fast-casual operators like Chipotle Mexican Grill. Many other restaurant operators have been dealing with what Paul Barron discussed in his book"The Chipotle Effect." In his book, he talked about how America's eating patterns have changed and the new generation of eaters don't want to dine at chains like the Olive Garden or Red Lobster. If a trend change has occurred in America's dining patterns, that's a big threat to Darden Restaurants' portfolio and things are about to get a lot uglier for the company. All of its concepts are sit-down concepts.

Source: Chipotle Mexican Grill

In looking at Chipotle Mexican Grill, you can see the support for Barron's argument. In the first quarter, Chipotle's same-store sales rose an amazing 13.4%. Total revenue increased over 24%. Chipotle added 44 new restaurants to bring its total restaurant count to 1,637. For the full year, the company plans to open a total of 180 to 195 new restaurants. Chipotle expects same-store sales growth in the high single-digit range.

Brinker International is bucking this trendHowever, that's not to say that all casual-dining restaurant stocks are struggling. A case in point is Brinker International and its concepts Chili's and Maggiano's Little Italy. In the most recent quarter, Brinker International's company-owned restaurants registered a 0.7% increase in same-store sales. Maggiano's has defied the industry trend and increased its same-store sales for 17 consecutive quarters.

Source: Brinker International

In terms of operations, investors are liking how Brinker International is run. Brinker International was able to improve its restaurant operating margin from 17.9% last year to 18.7% in this year's third quarter. The end result was that earnings per share rose almost 17%. It's this execution that explains Brinker International's share performance in comparison with that of Darden. So far this year, shares of Brinker International are up over 10%. Darden Restaurants, on the other hand, is down over 10%.

Foolish final thoughtsExecutives at Darden Restaurants certainly have their work cut out for them after this most recent quarter. Things are about to get even more interesting as Starboard Value is making a play for the entire board at Darden Restaurants' annual meeting. Starboard Value is not happy with the Red Lobster sale and feels the chain is worth more than $2.1 billion. CEO Clarence Otis was hoping that by selling Red Lobster and paying down $1 billion in debt and funneling the rest toward share buybacks that he would be able to appease shareholders. It doesn't look like that is happening and shares of Darden Restaurants will likely remain weak. The next step looks to be waiting and seeing what happens at the annual meeting. In overall terms, I see value in Darden Restaurants, unfortunately the market is not liking what it's seeing right now.